Organisation de Coopération et de Développement Économiques
Organisation for Economic Co-operation and Development 12-Jun-2014 ___________________________________________________________________________________________
English - Or. English DIRECTORATE FOR FINANCIAL AND ENTERPRISE AFFAIRS
COMPETITION COMMITTEE
AIRLINE COMPETITION
-- Background Paper by the Secretariat --
18-19 June 2014
This document was prepared by the OECD Secretariat to serve as a background note for Item IX at the 121st meeting of OECD Competition Committee on 18-19 June 2014.
The opinions expressed and arguments employed herein do not necessarily reflect the official views of the Organisation or of the governments of its member countries.
More documents related to this discussion can be found at http://www.oecd.org/daf/competition/airlinecompetition.htm.
JT03359273
Complete document available on OLIS in its original format
This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.
DAF/COMP(2014)1
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Eng lis h O r. Eng lishTABLE OF CONTENTS
Introduction ... 3
1. Features of the airline industry ... 4
1.1. Liberalisation of the air transportation industry ... 4
1.2. Business models and industry consolidation... 6
a. LCC entry and new business models ... 6
b. Consolidation and co-operation through alliances ... 9
1.3. Financial distress and government intervention ... 12
2. Competitive landscape of the airline industry ... 15
2.1. “What does an airline need to enter and compete?” ... 15
a. Exogenous/structural barriers ... 15
b. Endogenous/strategic barriers ... 17
2.2. “What do airlines compete on?” ... 19
a. Price ... 19
b. Quality... 21
3. Airline competition issues and antitrust enforcement ... 22
3.1. Market definition in the airline industry ... 22
3.2. Horizontal strategies: alliances, mergers and cartels ... 24
a. Alliances ... 24
i. Which competition concerns arise from airline alliances?... 25
ii. Have alliances succeeded in bringing upon efficiencies? ... 27
iii. Which competition enforcement tools apply to airline alliances? ... 29
iv. What decisions and remedies apply to airline alliances? ... 33
b. Mergers ... 34
c. Cartels and horizontal restrictions ... 37
3.3. Unilateral practices: exclusion/predation in the airline sector ... 40
a. Exclusionary pricing and selling strategies ... 41
b. Refusals to grant access to essential inputs ... 46
4. Conclusion ... 47
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BACKGROUND NOTE By the Secretariat1
Introduction
Why does the airline sector matter?
1. Between 1980 and 2013, the airline sector has grown substantially. According to the International Civil Aviation Organisation (ICAO), passenger trips increased from 4.028 billion in 1980 to 19.125 billion in 2012.2 International scheduled passenger traffic grew by 5.2% in 2013 in comparison to 2012 and is expected to reach over 6.4 billion passenger by 2030.3
2. The number of travellers has increased because, among many other things, prices have decreased significantly in response to increasing competition in the air transport market. For example, “in 1974 the cheapest round-trip New York-Los Angeles flight (in inflation-adjusted dollars) that regulators would allow: $1,442. Today one can fly that same route for $268”.4
3. With respect to cargo, although only around 0.5% of the volume of world trade shipments is carried by air, it accounts for over 35% in terms of its value. This means that air transport is indispensable for the speedy delivery of high value commodities, and other time-sensitive and perishable goods.
4. Increasing demand for air transport services has been facilitated by, and contributed to, the expansion of the global reach of airline networks. In 2012, airlines launched new services for a net addition of 974 airport pairs, while flight frequencies remained stable.5 Expanded networks increase air connectivity, which in turn increases states’ access to foreign markets. Overall, increased connectivity has been found to enhance the economy’s overall performance and productivity.6
5. It is expected that, by 2026, aviation will contribute $1 trillion to world’s GDP. Worldwide, aviation and related tourism generate over 56 million jobs, of which 8.36 million are directly linked to the aviation sector. Around 35% of international tourists travel by air.7 These numbers clearly illustrate how vital the international airline sector is in the increasingly inter-connected and globalised world’s economy. Air transportation spurs international trade and investment, tourism as well as growth of many other industries, thereby contributing to the growth of the overall economy.
1 This paper was written by Mona Chammas and Anna Pisarkiewicz with a valuable contribution from Simon Bricka, OECD Competition Division. All footnotes are cited in full in the bibliography attached to this Background Note.
2 Author’s calculations from World Bank international and domestic passenger data, based on an ICAO Press Release, 16 December 2013.
3 ICAO Press Release, 16 December 2013. 4 Breyer (2011).
5 IATA (2013), Annual Review.
6 For a detailed economic overview of the benefits of the aviation industry on consumers, public finances and the global economy see country reports prepared by IATA in cooperation with Oxford Economics. 7 IATA (2013), Annual Review.
6. The impact of the airline sector on the performance of other industries and global economy explains why it is essential to ensure that airlines operate in a level playing field.
Why does airline competition matter?
7. Since the airline sector has been de-regulated, air travel has to a large extent become a commodity and air services have become market-driven. Driven by lower prices and growing income, air traffic for passengers and cargo has grown exponentially. Airlines started offering lower fares to consumers under the pressure from increasing competition, which was spurred by liberalisation and de-regulation of the air transport sector. While many agree that overall the evolution of the sector has produced significant benefits to consumers, concerns about anti-competitive behaviours remain.
8. One of the most striking features of the international air transport sector is the variety and number of co-operation arrangements between airlines. These are typically used to reduce costs and spread the operational risk. However, any kind of horizontal co-operation between airlines, be it a basic interlining agreement or a full horizontal merger, may produce anti-competitive effects. In addition, many airlines (in particular incumbent carriers) may still have the ability and incentives to abuse the dominant position they inherited from the period preceding liberalisation. For example, legacy carriers may use their privileged position in a hub airport or engage in a predatory strategy with a view to deterring entry into the market in which they are present.
9. Given the nature and scope of air transport activities, the lack of a level playing field as well as harm from anti-competitive transactions or behaviours in the airline sector may have a deleterious effect on other sectors as well as the economy as a whole.
10. This Background Note highlights the most pressing and timely concerns that competition authorities are likely to face with respect to the international air transport sector. It focuses on civil international air transportation for passengers. Vertical aspects (e.g. airline-agent relationship) and purely cargo and domestic matters are excluded for purposes of the present Roundtable and Background Note. Section 1 describes the current regulatory framework and main features of the airline industry. Section 2 provides an overview of the competitive landscape in which airlines operate, and Section 3 addresses antitrust enforcement and airline competition issues.
1. Features of the airline industry
11. This section provides background on the airline industry operating environment, focusing first on liberalisation and de-regulation (section 1.1.), then on various business models that have sprung up following liberalisation (section 1.2.). This section turns next to airlines’ financial distress, a recurrent problem in the airline industry (section 1.3.).
1.1. Liberalisation of the air transportation industry
12. In contrast to many other industries with transnational reach, airlines’ commercial freedom is subject to many restrictions. Airlines operating international air transport services have to comply with different and often complex international and national regulatory regimes. Applicable regimes may control the market by putting in place a specific economic regulation, but they may also pursue policy considerations in such diverse areas as environment safety, consumer and environmental protection. While these additional policy considerations also have an impact on economic dynamics, the overview of the regulatory framework provided below is limited to economic regulation.
13. Regulation of air transportation. The Chicago Convention of 1944 established the International Civil Aviation Organization (ICAO), a specialised agency of the United Nations charged with the
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ordination and regulation of civil international aviation. At the same time, the Convention established formally that every State has “complete and exclusive sovereignty over airspace above its territory”.8 This principle still influences and limits today’s international air transportation, since it gave every States the power to decide who is allowed to fly through its airspace, including landing and take-off. The Convention also strengthens that international air transport services should be established on the basis of “equality of opportunity and operated soundly and economically”.9 As of 2013, the Chicago Convention had 191 state signatories. In contrast, the regulation of domestic air services has been left to individual countries.
14. The WTO-GATS Annex on Air Transport Services applies to international air services, but traffic rights and traffic-related services, which form the largest part of air transport services, have been excluded.10 This explains why most of air transport services are regulated and negotiated by sovereign states, predominantly through bilateral air service agreements (ASAs).
15. ASAs are the main legal basis on which international air services are provided today. ASAs typically determine the economic conditions, under which airlines can access, operate and provide services across the two signatory countries (reciprocal traffic rights). Such conditions can be far reaching, e.g. setting routes, frequencies and capacities. According to IATA, as of 2007, there were over 3,000 active ASAs. This means that, despite the global nature of air transportation, airlines continue to operate under complex, fragmented and diversified regulatory frameworks.
16. Most bilateral ASAs include restrictions on foreign ownership and control, under which airlines operating designated international air transport services, must be “substantially owned and effectively controlled” by one of the contracting states.11 While such restrictions are to some extent justified by various safety and security reasons, they effectively “impose an artificial industry structure on the air carrier sector that does not exist in other industries”,12 thereby limiting the airlines’ commercial freedom. In particular, the ownership and control rules restrict the possibility for cross-border mergers and acquisitions, a restriction that does not exist in other industries.
17. Besides state-imposed regulation, airlines have launched a number of self-regulation initiatives, which have also shaped how the airline industry operates. In particular, the International Air Transport Association (IATA) was established in 1947 to provide technical support to ICAO and to adopt industry standards.13 Today, IATA members represent approximately 85% of total air traffic worldwide.14
18. De-regulation and liberalisation. Liberalisation in the aviation sector presaged major structural changes. First, in 1978, the United States’ (U.S.) Congress passed the Airline De-regulation Act, which effectively liberalised the U.S. domestic aviation market after 40 years of restrictive regulation. A year later, US Congress adopted the International Air Transportation Competition Act with a view of promoting liberalised bilateral ASAs with other countries. A major break-through with respect to international aviation took place in 1992 when the U.S. signed the first Open Skies agreement with the Netherlands,
8 ICAO (1944), Chicago Convention, First Edition. 9 ICAO (2006), Chicago Convention, Ninth Edition.
10 WTO, General Agreement on Trade in Services (GATS), Annex on Air Transport Services, April 1994. 11 The ownership restriction determines the maximum percentage of airline shares that can be owned by
foreign nationals.
12 ICAO (2013), ‘Working Paper on Air Carrier Ownership and Control Clauses in Bilateral Air Services Agreements’.
13 For information about IATA, see: http://www.iata.org/about/Pages/index.aspx. 14 See section 3.3.c. below for further developments on IATA standards.
which eliminated capacity and frequency constraints for flights between the two countries. Today, the U.S. has over 100 open-skies agreements.15
19. After the U.S., many other countries followed suit and undertook to liberalise their airline sector, which often included privatisation of state-owned airlines. New Zealand started liberalising its airline sector in 1983, Canada in 1984 and Australia in 1990. The European Union (E.U.) implemented liberalisation measures during the period from 1988 to 1997. Although many countries have liberalised their aviation sector, as of 2007 only 17% of international air traffic was conducted in a liberalised operational environment.16 Thus, despite important progress, many countries still have to liberalise “their” airline sectors.17 Liberalisation may vary across countries taking into account “the unique characteristics of their own economic, political, and physical conditions”.18
20. Impact of liberalisation: Various authors have examined the impact of liberalisation on such diverse and at the same time inter-related aspects as connectivity, network structure, competition, consolidation and pricing. While mixed findings have been reported, it is safe to say that liberalisation has produced some clear benefits. With increased competition, prices have fallen, productivity has increased, airline networks have been optimised and the number of passengers has increased.19 In addition to the positive impact on competition, liberalisation of the airline sector decidedly has a potential to significantly contribute to the growth of the overall economy.
21. De-regulation and liberalisation of the air transport sector raise continuing questions regarding government intervention. Air transport “markets” were not a given: both governments and airlines are learning how to navigate the growingly liberalised environments and market dynamics. Open market forces may still fail sometimes and lead to economic inefficiency, market foreclosure or consumer harm. One of the main regulatory changes following liberalisation was the progressive adoption of competition laws around the world.
1.2. Business models and industry consolidation
22. De-regulation and liberalisation of civil air transportation have opened the door to dramatic changes in the airline industry. Two essential game changers distinguish the airline industry of today from that of 1975: low-cost carriers (LCCs) have entered the markets, leading to a range of new business models. In parallel, the industry has been marked by a consolidation trend, which essentially took place through airline alliances.
a. LCC entry and new business models
23. LCC entry. De-regulation of air transport markets dominated mostly by state-owned or legacy carriers enabled entry by low-cost carriers (LCCs) in various parts of the world. LCCs penetrated the air
15 For the full list of the US Open Skies partners, see: http://www.state.gov/e/eb/rls/othr/ata/114805.htm. 16 IATA (2007).
17 For example, ASEAN countries have to fully liberalise air transport services by 2015. 18 Shaw, et al. (2009).
19 For a critical study of the impact of de-regulation, see e.g. Goetz and Vowles (2009) who identified “The Good, the Bad and the Ugly” of de-regulation and liberalisation policies over a 30-year period. The Good referred to higher passenger volumes, more service to the most popular destinations and lower fares on average. The Bad referred to financial and employment instability, lower quality of airline services overall, fewer flights and higher fares for flights to smaller places. The Ugly referred to the loss of $30 billion overall and the bankruptcy of high-profile carriers over the period 2000-2005.
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transport markets by offering low-fare, point-to-point and no-frill flights, mainly on short-haul routes where there was sufficient potential demand from price-sensitive consumers. Overall, LCCs have grown rapidly. Worldwide they account for 26% of total seat capacity and for 22% of total frequency.20
24. In parallel to LCC entry, legacy carriers undertook a number of steps to rationalise their operations by replacing point-to-point structure with a hub-and-spoke network. A hub-and-spoke network, which typically consists of a central airport (the hub) and many secondary airports (spokes), has emerged as the most efficient model for this type of airlines: it allows airlines to optimise their operations by exploiting economies of scale, scope and density.
25. Shortly after the industry liberalisation, the landscape of the aviation markets was thus relatively simply to describe as it featured two main business models: full-service carriers (FSCs), i.e. legacy airlines; and LCCs, the new entrants.21 The main characteristics that distinguish FSC and LCC business models are summarised in Table 1 below:
Table 1. Comparison of FSC and LCC business models
Features FSCs LCCs
Core business Passenger and Cargo Passenger Consumer base All – economy and business Economy
Network Hub-and-spoke often at main airports Point-to-point often between secondary airports
Coverage Domestic, international and
intercontinental Domestic and continental
Ticketing Round-trip ticket One-way ticket
Ticket selling Various distribution channels (e.g.
agency, direct) Direct on-line
Aircraft Cabin divided into economy and premium (first/business) class
Single class cabin
Fleet Diversified Uniform
Product bundling/ differentiation
Frills (i.e. complimentary services) No frills
Customer management FFP No FFP
26. These features have to various extents contributed to the fact that LCCs have lower operating costs than legacy carriers.22 But LCCs have also lower profit margins than legacy carriers (due to no premium class), which requires a high load factor. Over time, as legacy carriers seek to improve their cost efficiency in order to respond to competition from LCCs, cost advantage of low-cost carriers may be reduced and price competition alone may become unsustainable.
20 International Transport Forum data.
21 Charter carriers are included in the low-cost carrier category: they provide low-cost air services and focus mainly on tourism, short-haul flights and price-sensitive holiday passengers.
22 Differences in operating costs typically have their source in higher seating density and higher daily aircraft utilisation. According to IATA (2006), in 2004 the operating costs per available seat kilometre (ASK) of the three largest US network airlines were 36% higher than those of Southwest (the main US low-cost carrier). In Europe, this difference was also quite substantial as operating costs of legacy carriers in 2004 were 40% and 64% higher than those of EasyJet and Ryanair respectively.
27. Hybridisation. In response to increasing competition and changing consumers’ behaviours, airlines continuously adapt their business models. This evolution is reflected by the hybridisation of airlines’ business models. There is growing consensus that “there is now a continuum of different business models in play rather than a simple categorization by discrete groups”.23 Klophaus et al (2012), for example, having examined European airlines operating on the four largest LCC markets in Europe (Germany, Italy, Spain and the UK), found that it was more appropriate to classify the airlines as: (i) pure LCC, (ii) hybrid carrier with dominating LCC characteristics, (iii) hybrid carrier with dominating full-service airline characteristics, and (iv) full-full-service airline.24 Examples from the industry reveal the ongoing hybridisation of airlines’ business models. As illustrated in Box 1 below, features that were previously seen as pertaining to a specific business model may no longer be seen as such.
Box 1. Hybridisation of airlines’ business models
On the FSC side: Certain FSCs have moved to offer low-cost services. Aer Lingus, has turned from the typical network carrier model to a low cost model that specialises in long-haul routes. Other legacy carriers, such as Qantas, Singapore or Lufthansa responded to competition from LCCs by creating their own LCC: Jetstar, Tiger and German Wings respectively. Some legacy airlines set up a joint venture to offer low-cost air services.25 In addition, FSCs are un-bundling their offer, separating no-frill flights from ancillary services, and pricing them separately.26 FSCs are also increasingly offering tickets via their own website rather than through traditional distribution channels.27 Fleet homogeneity or heterogeneity also no longer allows differentiating between FSC and LCC,28 as FSCs today tend to rely on homogenous fleet, at least on short-haul routes.
On the LCC side: Some LCCs have adopted the FSC model. Virgin Australia, for example, initially a LCC known as Virgin Blue, has become a full-service airline operating both domestic and international flights. LCCs are also increasingly offering FSC-like services, such as frequent flyers programs, priority boarding and extra luggage, as opposed to their traditional no-frill offer.29 These new services reflect LCCs’ move towards attracting demand from more customer segments (e.g. business passengers). LCCs further seek to geographically expand their networks by offering long-haul routes and by moving to primary airports: e.g. Air Berlin, Aer Lingus and Meridiana have launched long-haul routes, whereas Ryanair has expanded to Brussels International Airport.30
28. The on-going hybridisation of airline business models is not surprising. Both established and new airlines need to have flexible business models to continuously adapt and remain profitable in a competitive environment. When examining competitive interactions between firms operating different business models,
23 Lohmann and Koo (2013).
24 Klophaus et al. (2012). See also CAPA (2013), ‘Airlines in Transition Reports’, which address some of the key transformational issues faced by the aviation industry including hybridisation, as LCCs evolve towards full service and as legacy airlines look for LCC solutions.
25 E.g. Jetstar Japan was created by Qantas and Japan Airlines while Jetstar Hong Kong was created by Qantas and China Eastern Airlines.
26 For example, some airlines have stopped offering complementary food for economy passengers (e.g. North American airlines), while others have started introducing fees for checked baggage (e.g. KLM and British Airways on their European routes) or charging for seat reservation.
27 Traditional distribution channels include mainly Global Distributions Systems (GDSs) and on-line or brick and mortar travel agencies.
28 Klophaus et al (2012) and Gillen and Gados (2008). 29 Such as Air Berlin in Europe and WestJet in Canada.
30 While various authors have questioned the viability of the long-haul low-cost carrier model, it remains to be seen whether LCCs operating transatlantic routes can successfully compete with legacy airlines on such markets. See e.g. Wit and Zuidberg (2012) and Morrell (2008).
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LCC-FSC competition seems more effective than LCC-LCC competition. In other words, LCCs have put downward price pressure primarily on FSCs, while potentially avoiding to compete head-to-head against other LCCs.31
b. Consolidation and co-operation through alliances
29. Liberalisation of air transport increased competition and prompted airlines not only to rationalise their own structure (e.g. hub-and-spoke), but also to find opportunities for growth through co-operation and consolidation with other airlines. This mainly took place in the airline industry through alliances. “Alliances” refer in this paper to any kind of horizontal co-operation agreement falling short of a merger, which may vary widely in scope and strength, as explained further in this section. The reasons for airlines to enter into an alliance are primarily legal and economic:
• Legal rationale. Multinational companies and cross-border mergers are common in most
industries. In the airline industry, cross-border mergers between airlines are uneasy due to nationality and ownership restrictions remaining in most open skies or ASAs. Under open skies agreements, the signatory countries grant their respective air carriers an operating license and traffic rights to fly between both countries. For that, they usually require that carriers be owned or controlled by nationals or by the state. A merger would usually entail a switch of control and ownership, leading the merged or acquired airline to lose its nationality, hence its traffic rights on international routes. This is why consolidation at international level is essentially achieved through alliances. Alliances, although varying in depth, allow indeed for co-operation and pooling of activities while preserving allied airlines’ ownership and control.32
• Economic rationale. Alliance strategies are rooted in network economics and in the globalisation of the economy: airlines’ network and worldwide presence has become a comparative and competitive advantage.33 It would be unsustainable however for each airline to serve alone every destination, while demand patterns vary in number, density, time and geography. Alliances enable airlines to broaden and deepen their network, to grow and to rationalise their costs, without expanding their own aircraft capacity or route offering. Alliances are thus seen as the second-best option after mergers to bring upon economies of density, scale and scope. Indian’s SEBI authority recalled the benefit-enhancing potential of alliances in its 2013 decision re: Jet Airways and Etihad’s alliance:
Commercial co-operation agreements are entered into by airlines to expand their respective networks to compete more effectively with other airlines, […]. Such an agreement merely facilitates rationalization of costs, efficiencies of scale and the ability to service different parts of the world by leveraging the presence of the partner airlines in that market.34
30. Early airline alliances consisted primarily in basic bilateral interlining (arms-length) arrangements. Interlining occurs when a passenger flies using just one ticket for the whole journey, with
31 Cento (2008) argues that “some LCCs have tried to avoid mutual competition”. Further studies may however need to evaluate the degree to which LCCs exert a competitive constraint on FSCs rather than other LCCs.
32 Whereas at domestic level (i.e. between carriers from the same country), consolidation occurs mainly through mergers.
33 Notably vis-à-vis strong and dynamic competition from LCCs and from Gulf carriers (although Qatar Airways joined Oneworld on 30 October 2013). See EU/DOT Alliance Report (2010).
multiple flight legs and distinct carriers. Interlining makes multi-carrier journeys seamless: at a transit airport, passengers do not have to collect their luggage or to check in again, and their baggage will automatically follow through to their final destination.35 Deeper and more effective interlining co-operation emerged through code-sharing agreements.Under a code-share agreement, a flight operated by one carrier (“operating carrier”) can be marketed by partner airlines too (“marketing carriers”) under their own code and designator.In other words, code-sharing allows two or more airlines to share the same flight while selling tickets on this flight as their own. Towards the late 1990s, co-operation grew on a multi-lateral level and resulted in the crystallisation of the industry around three global branded alliances: Star, SkyTeam and OneWorld.36 These global alliances capture 55% of the global market share, measured in available seat-kilometres for total scheduled passengers.37 The remaining 45% is shared among LCCs and other non-allied airlines.
31. The following graph, from the EU/USDOT report on alliances, summarises the main types of airline alliances according to their degree of co-operation and integration:38
32. As shown in the above graph, every alliance may vary in width and depth. In practice, alliances may consist in a complex combination of features and should thus be examined on a case-by-case basis. Although various typologies may be offered to classify airline alliances, most alliances fall in one of these two categories:
• Low-level to mid-level co-operation: these are “traditional” or “standard” alliances ranging from basic interlining agreements, to co-operation pertaining to airport lounges, terminals, IT platforms, check-in operations, frequent flyer programs or code-sharing. Star, SkyTeam and OneWorld fall in this first category, to varying degrees.
35 Beuve-Méry and Struk (2007).
36 Star Alliance was established in 1997, Oneworld in 1999 and SkyTeam in 2000. 37 CAPA, Centre for Aviation (2011).
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• High-level co-operation and integration (“joint ventures”): these are far-reaching agreements involving (i) coordination on competition parameters, such as prices, schedules, capacity, facilities and other sensitive information; (ii) sharing costs, revenue and/or profits; and/or (iii) acquiring a (minority) interest in allied airlines.
33. The latter category of alliances, namely far-reaching joint ventures, are deemed more likely to achieve merger-like synergies and efficiencies. At the same time, they may require substantial investments by the allied airlines to implement the foreseen level of integration, and integration can be difficult to adjust or unwind if needed. Integrated joint ventures among actual or potential competitors are also more likely to give rise to competition concerns.39
34. Alliance dynamics and inter-alliance competition may evolve over time, depending on the regulatory and economic environment in which allied and non-allied airlines operate. Today’s driving alliance dynamics and trends are summarised in Box 2 below:
Box 2. Recent trends in airline alliance dynamics
Growth. The evolution of airline alliances and partnerships has been rapid and far reaching;40 co-operation between airlines has overall increased in breadth and depth.41
Stratification. Within the three global alliances, Star, SkyTeam and OneWorld, more integrated joint ventures are being set up by sub-groups of allied airlines.42 Code-share agreements and joint ventures are also concluded between alliance members and non-allied airlines.43 These spin-offs may provide additional benefits while at the same disturbing the global alliance dynamic.
Regulatory. As long as nationality and ownership limitations are contained in ASAs stand firm, deeply integrated JVs will remain airlines’ main strategy to access global markets.44 On the regulatory side though, “there are some signs of a less protectionist approach, with more openness to considering cross-border ownership and control, facilitating greater use of equity stakes.”45
39 See section 3.2. below for a competition assessment of alliances. 40 CAPA (2013), ‘Airlines in Transition Part 1’.
41 EU/DOT Alliance Report (2010).
42 For example, (i) Star Alliance’s United/Continental, Lufthansa and Air Canada engaged into a transatlantic joint venture involving extensive cooperation on pricing, capacity and scheduling coordination as well as the sharing or revenues, (ii) Star Alliance’s Air Canada and United engaged into a US/Canada revenue-sharing joint venture, (iii) SkyTeam’s Delta, Northwest, Air France, KLM, Alitalia and Czech Airlines engaged into a transatlantic joint venture involving a metal neutral joint venture between Delta, Northwest, Air France and KLM, and (iv) Oneworld’s American Airlines, British Airways, Finnair, Iberia and Royal Jordanian Airlines engaged into a transatlantic joint venture involving cooperation on all flights and services.
43 Nowadays, 14% of Star Alliances routes and 38% of OneWorld routes are operated with non-members. CAPA (2013) ‘Airline Alliances – what Future? Global, Multilateral and Bilateral Partnerships are Evolving’.
44 Ibid.
Equity. Equity-based alliances are emerging as a growing consolidation model. Equity investments, such as Etihad’s or Lufthansa’s minority stakes in other airlines, can secure and deepen an existing partnership, 46 signal a proprietorial position,47 prevent a competitor from taking a partner over, and facilitate mutual learning. LCC entry. Global alliances members are predominantly FSCs or legacy carriers. Alliances do not exclude the possibility of opening up to LCCs, provided it would be mutually beneficial.48 A recent phenomenon of alliance hybridisation is slowly emerging, as SkyTeam, for instance, unveiled in 2012 a platform for partnership with selected LCCs.49 Whether cautious openings will benefit or disrupt alliances and competition altogether, remains to be seen. LCCs may also find more opportunities in strategic bilateral JVs with selected FSCs.
Gulf carriers. Alliances have faced a shift of global power towards Asia in recent years.50 Gulf carriers in particular - Emirates, Etihad and Qatar Airways – post the world’s strongest growth rates and attract growing international demand. Qatar Airways joined OneWorld in 2013, but Emirates and Etihad are pursuing their own partnership strategies.51 These carriers are described as the main threat and destabilising factor to global alliances and legacy carriers. At the same time, Gulf carriers’ success may incentivise inter-alliance competition to remain attractive and competitive.
35. Accordingly, while global alliances are still at the heart of co-operation and consolidation in the industry, strategic joint ventures within and outside global alliances, hybridisation processes, and Gulf carriers’ growth, will keep shaping and shaking the alliance world. The evolution and consolidation of the airline industry through alliances suggests that alliance competition may to some extent replace airline competition.
1.3. Financial distress and government intervention
36. The airline industry has been famous throughout the years for featuring a large number of distressed companies, bankruptcies and market exits. Is financial distress inherent to the industry? Are most airlines condemned to face financial difficulties at some point? What explains that legacy carriers are struggling, whereas most low-cost carriers52 and new full-service carriers53 have been successful? Is it a
46 CAPA (2013) ‘Airline Alliances – what Future? Global, Multilateral and Bilateral Partnerships are Evolving’.
47 As of January 2014, Etihad’s investments included 29% of Airberlin, 40% of Air Seychelles, 19.9% of Virgin Australia, 24% of Jet Airways, 3% of Aer Lingus, 49% of Air Serbia and 33.3% of Darwin Airline, CAPA (2014).
48 See discussion with alliance representatives and leaders in CAPA (2013) ‘Airline Alliances – what Future? Global, Multilateral and Bilateral Partnerships are Evolving’.
49 Star is considering a similar opening, mainly targeting Brazil and India: CAPA (2013), ‘Star Alliance Considers New Platform for Low-Cost Airlines, Targeting Brazil’s Azul & India’s IndiGo’.
50 Airline Leader, ‘Global Airline Alliances: Transformed by Antitrust Immunity, but Confronted by Uncertainty’.
51 Emirates entered into partnership agreements with Qantas (Oneworld member) and Tap Portugal (SkyTeam member), whereas Etihad is developing its own alliance network through equity-based investments and code-sharing agreements. For further commentary on Gulf carriers’ impact on alliances, see e.g. Parker (2013) and CAPA (2013), ‘Airlines in Transition Part 1’.
52 E.g. easyJet, Ryanair, Southwest and Spirit. Some LCCs discontinued their operations however, such as SkyEurope (2009) Wind Jet (2012) in Europe.
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matter of good management, business model, market structure, state support, legacy labour agreements, de-regulation or remaining de-regulations?
37. The primary question to most observers is whether de-regulation and liberalisation made air carriers less viable financially. As S. Borenstein points out, at the time when carriers were state-owned and heavily regulated, most of them were consistently unprofitable or “chronic loss-makers”.54 Their financial distress was only less visible due to systematic subsidisation of the failing carriers. “Firms could count on surviving even after chronic losses, and this expectation left its mark on their behaviour.”55
38. Financial distress can result from a combination of internal and external factors. Internal factors primarily pertain to bad management decisions, including excess capacity investments, inflated personnel, excessive bureaucracy, unprofitable routes and ineffective network planning. External factors often consist in fuel price volatility, financial and economic crises, shifting demand, labour costs or increased competition (for example from LCCs). Japan Airlines, for example, faced serious financial difficulties in 2010 as a result of excess capacity (fleet) and personnel, unprofitable routes, bureaucratic management and a drop in demand during the financial crisis.56 These reasons can become all the more important when airlines facing changes in the market are confronted with rigidity stemming from labour legislations or the lack of flexibility in their operations.
39. Effective competition may also play a role in some airlines’ financial difficulties: in highly competitive markets, only the most profitable and well-managed carriers may be sustainable. This holds true for any industry, as competition rewards the most efficient players at the expense of the others. On the other hand, unfair competition may cause or exacerbate financial distress: state-supported new entrants (as alleged of some LCCs and Gulf carriers), tax-free airports, and low-cost employment in some regions, are often pointed to as reasons for legacy carriers’ difficulties. Unfair competition raises the broader and uneasy question of what a level playing field is in the airline sector.
40. An airline may have recourse to various tools to achieve financial recovery, one of which is consolidation, through mergers and alliances. Although consolidation is likely subject to merger control, competition authorities tend to take serious financial distress into account in assessing merger effects, and may actually approve an otherwise anticompetitive merger if it would not be worse than losing the failing airline absent the merger. The acquisition of Olympic Air by Aegean Airlines, for instance, was first rejected in 2011 by the European Commission as entailing anti-competitive effects. In 2013, the same merger was approved on failing firm grounds.57
41. Where business recovery tools fail, governments face the question of whether or how to respond. In the airline industry, failure may also have certain harmful consequences, such as reduced access and frequency of air transport, adverse labour and social impact, lower coverage of small or remote areas, negative impact on related businesses. These are reminders that, although privatised, airlines serve the public interest and global economy, and airlines are not easy to replace. These various policy concerns explain why governments have sometimes adopted rescue, bail-out or state aid plans.58 Such aids usually come with strings attached, i.e. conditions to ensure sustainable recovery. A number of government aids
54 McCarthy (2013). 55 Kornai et al.
56 JFTC, Presentation by Commissioner Odagiri, 2014.
57 European Commission decisions Aegean Airlines/Olympic Air I (2011) and II (2013).
58 Government “intervention” may take various forms, e.g. capital injection, subsidies, loan grant, debt forgiveness, tax advantage, or partial (re-)acquisition by the State.
have proven successful, such as the bail-out of American carriers in 2001 and the rescue of Japan Airlines in 2010.59
42. Government aid can also be controversial, as it carriers various dangers, let alone the risk of a failed rescue plan. The first danger is that state intervention may distort the playing field. As pointed by ICAO, “some governments may be tempted to lend support to their airlines through means that could deny the airlines of other States a fair and equal opportunity to compete.”60 A second danger is that state aid may increase inefficiencies overall, as it sends a strong signal to the business that inefficient airlines could be rescued.61 The challenge consists thus in determining whether the adverse consequences of letting a carrier fail, outweigh the risks of un-levelling the playing field and of inducing potential longer-run inefficiencies. 43. While competition laws ensure that companies’ practices do not distort competition, they cannot generally prevent state-induced distortions of competition. The European Union is the only jurisdiction in the world that has adopted binding “state aid law”, including rules and limitations applicable to state aid envisaged by EU governments.62 These rules aim to ensure fair competition and a level playing field across EU member States and companies; they have been applied to air transport.63 Concerns with subsidies can arise at global level. They are sometimes, but not consistently, addressed in bilateral ASAs through the enumeration of non-permissible state aid mechanisms likely to adversely affect a fair and competitive environment.64
59 In 2001, the United States offered struggling American airlines US$ 5 billion in emergency aid (post 9/11) and loan guarantees up to US$10 billion.59 The loan programme allowed airlines to recover, some of which merged afterwards. Absent the bailout, airlines may have gone bankrupt before any merger and stabilisation opportunity. More recently, Japan adopted a revitalisation plan in 2010 to rescue collapsing legal carrier Japan Airlines. Revitalisation conditions included divestitures of affiliated companies and reductions in capacity (aircrafts) and in labour costs. Two years later, the airline posted record profits. Other rescue plans may prove less successful, as shown by the current financial difficulties faced by Air India and Malaysian Airlines despite prior government intervention.
60 ICAO (2013), Working Paper on Fair Competition in International Air Transport.
61 This phenomenon is described by economist J. Kornai as the “soft budget constraint syndrome”; see Kornai, ‘The Soft Budget Constraint’, http://faculty.vassar.edu/kennett/Kornai.htm and further developments at https://www.sss.ias.edu/files/papers/econpaper19.pdf.
62 It also sets for a notification system under which governments must submit their aid plan for approval by the European Commission. Articles 107 to 109 of the Treaty on the Functioning of the European Union contain the main dispositions regarding State aid in the European Union. These articles are complemented by European Commission guidelines, including specific guidelines regarding rescue and restructuring aids (Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty) in force since 2004. The European Commission is currently in the process of reviewing its guidelines for rescue and restructuring aid for non-financial undertakings in difficulty.
63 At the same time, they may put the competitiveness of the EU industry at a competitive disadvantage in relation to the rest of the world, where state aid remains un-regulated.
64 These provisions follow the ICAO guidelines: ICAO (2004), Manual on the Regulation of International Air Transport
http://www.icao.int/sustainability/Documents/Compendium_FairCompetition/InternationalOrganisations/I CAO-doc/ICAO-Doc9626_en.pdf. See also ICAO (2013), Working Paper on “Fair Competition in International Air Transport”, 18-22 March 2013,
http://www.icao.int/sustainability/Documents/Compendium_FairCompetition/InternationalOrganisations/I CAO-doc/ATConf6-wp004_en.pdf.
15 2. Competitive landscape of the airline industry
44. To understand the competitive landscape in which airlines operate today, two central questions are addressed in this section: What does an airline need to enter and compete in the provision of passenger air transportation services? And what do airlines really compete on? The first question pertains to essential inputs and potential barriers to market entry, such as take-off and landing slots (section 2.1). The second question deals with the main parameters on which airlines compete, namely price and quality (section 2.2). 2.1. “What does an airline need to enter and compete?”
45. In the initial years of liberalisation of the air transport market, the airline industry was described as being close to perfectly contestable.65 A perfectly contestable market exists where there are no barriers to entry and no barriers to exit, so that potential competitors can engage in so-called ‘hit-and-run’ competition. This means that entry must be reversible and costless. While liberalisation of international air transport markets is still ongoing, the current experience with de-regulated markets makes it clear that this industry is to a large extent characterised by high barriers to entry, and thus can hardly be described as very contestable.66
46. To enter the market and compete in the provision of air transport services, a company essentially needs aircrafts (e.g. through ownership or lease), operating licences and traffic rights, personnel, feeder access, take-off and landing slots, and access to airport facilities (e.g. check-in facilities and gates). Some of these inputs are not scarce (e.g. aircrafts), whereas other inputs may be limited in number or size (e.g. airport facilities) and constitute barriers to entry. This type of barriers to entry is usually referred to as exogenous or structural.
47. Other barriers to entry may instead originate from the behaviours of firms present in the market, which raise the costs for new entrants. These barriers to entry are usually referred to as endogenous or strategic. Frequent flyer schemes, which increase consumers’ loyalty, are a good example.
a. Exogenous/structural barriers
48. Airport congestion today is arguably the most critical barrier deterring entry into certain routes. Airport congestion occurs where demand exceeds airport capacity.
49. According to IATA, as of April 2014, there were around 167 congested airports in the world: 100 in Europe, 36 in the Asia-Pacific region, 13 in North Asia, 11 in Middle East and Africa and only 7 in America. Various studies show that the problem of congestions is most acute at major hub airports, such as London Heathrow, Frankfurt and New York JFK.
50. Given the gap between demand and airport capacity, and the unlikely expansion of most congested airports, governments have adopted congestion management measures consisting essentially in creating slots and introducing slot allocation rules.67 A slot is defined by IATA as “a permission given by a coordinator for a planned operation to use the full range of airport infrastructure necessary to arrive or depart at a Level 3 airport on a specific date and time.” A Level-3 airport is an airport that cannot meet
65 Bailey and Baumol (1984).
66 Baumol and Willig (1986); Goetz (2002); and Goetz and Vowles (2009).
67 To reduce the demand-to-capacity ratio, it is debated in the economic literature that policy-makers should opt for capacity management and/or for demand management measures. See e.g. Airport slot allocation: a time for change. See e.g. Madas and Zografos (2010).
demand, either due to insufficient infrastructure/capacity or due to government-imposed restrictions.68 Slots consist thus mainly in take-off and landing rights permission at constrained airports.
51. The scarcity of slots at capacity-constrained airports has led to the emergence of various primary and secondary slot allocation regimes. Primary slot allocation refers to the first time a slot is established and allocated (by the government or an appointed co-ordinator) to an air carrier. Secondary slot allocation refers to slot trading between the primary slot holders and candidate airlines seeking new or additional airport slots.
52. Given the importance of slots for the operation of air transport services, it is essential that slot-allocation regimes contribute to the creation of a level-playing field. Primary slot slot-allocation should therefore be guided by principles of neutrality, transparency and non-discrimination and should ensure the most efficient use of slots by airlines. In many airports, however, slots have been allocated to incumbent carriers, granting them a privilege based on their historical presence, but not on an efficiency evaluation. New entrants would only be able to acquire slots if an incumbent carrier decided to return its slots to the “pool”. The returned slots would then be re-allocated (by the pool co-ordinator) to another airline. Some systems would favour re-allocation of returned slots to new entrants.69
53. In various jurisdictions, like the EU, so-called “grandfather rights” were granted to primary slot holders: if the slot holder operates at least 80% of its assigned slots during a given scheduling period, it can keep the same slots for the next period. If the slot holder has not reached the threshold, the unused slots have to be re-allocated (“use it or lose it” rule).70 Slot holders under such regime are not allowed to sell or to buy slots as they wish. They may be allowed to exchange slots on a one-to-one basis, but this requires that both airlines already be slot holders. As a result, there is no slot market and there is no such principle as free or equal access under these primary slot allocation regimes. As pointed by the UK’s OFT (now CMA), the “current system creates rigid incumbent slot holdings that are slow to respond to changes in demand conditions and this inertia creates significant barriers to entry and expansion”.71
54. In addition, the “use it or lose it” rule has led to adverse strategies and inefficiencies. A slot-holding airline may decide to use a slot only to keep it, whereas the slot could be used more efficiently by another airline. Slot holders’ withholding strategies, combined with rigid slot allocation rules, raise barriers to entry and expansion at most constrained airports. The above concerns have led most policy makers around the world to favour the creation of a slot market, namely a market allowing for secondary slot trading among airlines. This secondary slot market would allow airlines to sell or lease their slots freely to other airlines, whether new entrants or expanding competitors.
55. The IATA 2013 Worldwide Slot Guidelines crystallise the co-existence of two slot regimes:
68 IATA (2013), Worldwide Slot Guidelines.
69 Article 6 of regulation (EC) No 793/2004 of the European Parliament and of the Council of 21 April 2004 provides that 50% of slots placed in the pool of available slots shall be distributed to new entrants. The question is whether new entrants could effectively compete with limited slot re-allocation.
70 EU Regulation 95/93 on common rules for the allocation of slots at Community airports, amended by Regulation 793/2004 and by Regulation 545/2009 regarding the use it or lose it rule for slots allocated for the summer season of 2010.
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1.7.1 The key principles of slot allocation are: […]
h) Historic slots may not be withdrawn from an airline to accommodate new entrants or any other category of aircraft operator. Confiscation of slots for any reason other than proven intentional slot misuse is not permitted.
i) Slots may be freely transferred or exchanged between airlines, or used as part of a shared operation, subject to the provisions of these guidelines and applicable regulations.
56. The principle of inherited primary slots harms competition and efficiency. At the same time, leaving slot trading wholly in the hands of slot holders may carry on new competition risks.Slot-holders may notably refuse to sell or lease their slots to exclude strong competitors or new entrants. This is why most congestion management studies conclude like H. Fukui that “the current bilateral slot trading system does not, on its own, necessarily secure effective slot trading”.72
57. To address these pitfalls, governments have considered adopting a hybrid approach: allowing for secondary slot trading while imposing conditions on trading mechanisms to promote competition and efficiency. Such conditions pertain essentially to how an airline is allowed to sell or lease its slots. The main mechanisms capturing the attention of governments and economists today are auctions, congestion or peak-load pricing, and trading through a clearing house.73 The US rescinded a project to auction slots at three New York airports,74 whereas the EU is still weighing various market-based mechanisms to deal with the capacity trading at constrained airports.75 Certain transport authorities may also consider imposing sanctions and fines against airlines for intentional misuses of slots.76
58. Competition law can tackle anti-competitive slot trading tactics only to a limited extent: a slot trading tactic may indeed, but rarely, amount to a restrictive agreement or an abuse of dominance.77 Absent a specific and detectable competition infringement, competition rules would generally be inapplicable to harmful slot-trading tactics. Sector-specific regulation could then play an important role in promoting competition and consumer welfare by setting appropriate slot trading rules in congested airports.
b. Endogenous/strategic barriers
59. Post-liberalisation, airlines have elaborated various strategies to reduce customers’ propensity to switch from one airline to another. The main strategy consists in rewarding customers for flying regularly with the same carrier. The three most common types of loyalty schemes are: frequent flyer programmes
72 For further developments on the pros and cons of slot trading, see UK OFT (now CMA) (2005) and Fukui (2010).
73 For a detailed analysis of various slot allocation schemes, see Holder et al. (2004); Madas and Zografos (2010) (promoting congestion pricing as the most efficient tool at cluster airports); Vaze and Barnhart (2011) (on the conditions for congestion pricing to be effective); and Fukui (2010).
74 In the US, in 2009, Obama’s Transportation Secretary rescinded plans for the introduction of a slot auction mechanism for 10% of slots at New York’s JFK, LaGuardia and Newark airports (http://www.iata.org/publications/airlines-international/august-2010/Pages/06.aspx).
75 In the EU, the European Commission’s Directorate General for Mobility and Transport introduced a legislative proposal regarding the introduction of market-based mechanisms across the EU. The proposal has been reviewed, modified and accepted by the European Parliament. The next step is for the Council of the European Union to deliver its first reading position.
76 Gleave (2011).
(FFP), corporate discount schemes (CDS) and travel agent commissions.78 This section concentrates on FFPs and CDSs.79
60. FFPs are personal loyalty programmes open to all travellers which enable them to accumulate bonus points. According to a survey carried out by Official Airline Guides, 90% of all business travellers are members of an FFP for a total of 120 million subscribers, a quarter of whom are active FFP members.80 FFP points are generally awarded per flight and vary depending on destination, length and fare category. These points can be exchanged for free services (e.g. free travel or free hotel accommodation) and enhanced service level (e.g. priority boarding or class upgrade). A frequent flyer would usually qualify for those benefits once he/she has accumulated points beyond given thresholds set by the airline.
61. The first FFP was introduced in 1981 by American Airlines81 and, since then, such programmes have been a characteristic of most FSCs.82 FFPs have evolved over time. Hybridisation of business models has led some LCCs, such as Vueling, Wizzair or Norwegian, to adopt FFPs.83 Many schemes have been broadened to include everyday spending at grocery stores, hotels or gas stations and therefore target everyday spenders, even though they may not be frequent air travellers.84 The most advanced forms of FFPs, such as Air Canada’s Aeroplan or Qantas’ Frequent Flyer, belong to so called “autonomous next generation programs” and are managed by separate companies.85 Another major evolution concerns alliances, which have introduced reciprocity in the ability to earn and use points across FFPs of various partner airlines.
62. CDSs are specific private contracts negotiated between an airline and a company, enabling the latter to obtain discounts on tickets purchased by its managers and employees.86 CDSs arrangements can offer companies lower net fares, or might be a way of transferring the benefits of FFPs from individual employees to the company.Airlines usually require that the company guarantee a minimum turnover to benefit from discounts or apply proportionality between discounts and number or type of flights booked.87 CDSs may also include clauses stating that the relevant airline should be given preference or that the company’s engagement should last for at least a year.88 With the development of airline alliances and code-sharing, CDSs may increasingly cover more than one airline.89
78 ECA (2005).
79 As described in the introduction, this Background Note, for the most part, does not aim to address vertical dynamics, such as airline-agent relationships.
80 This survey is pointed out in Hanlon (2007). 81 Boer and Gudmundsson (2012), page 18.
82 See Barrett (2001); and Tomová and Ramajová (2014), page 787. 83 Tomová and Ramajová ( 2014 ), page 788.
84 According to Boer and Gudmundsson (2012), page 23: more than 50% of points are earned on non-flying activities.
85 Ibid. These new entities will often be owned by airlines even though investment by a third party is possible.
86 According to Hanlon (2007), Chapter 3. Competition Issues, page 95: a company has between 5 and 20 corporate contracts (9 on average) with airlines.
87 ECA (2005), page 7. 88 ECA (2005), page 19.
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63. FFPs and CDSs offer clear direct benefits to consumers, through better quality and/or lower prices. They may also increase rivalry between airlines, which compete on offering the best loyalty programme and rewards. However they may also lock-in companies (beneficiaries) because the discounts offered may reduce their willingness to switch to other airlines. Whether such benefits increase consumer surplus and social welfare requires balancing FFPs’ and CDSs’ benefits against their potential anti-competitive effects.90
64. Governments may also decide to address concerns of competition distortion and consumer harm by imposing a regulatory ban on FPPs. This may be necessary where FFPs are found to reduce competition, but do not constitute competition law infringements. Norway, for example, decided in 2002 to prohibit the possibility of earning points through SAS’s FFP on all domestic routes.91 This ban was based on the strong loyalty effects generated by the FFP, which locked in customers. Norwegian, a LCC, entered the market during the ban period. According to the LCC, the ban was a decisive factor in its decision to enter the market.92
2.2. “What do airlines compete on?”
a. Price
65. Airlines compete first and foremost on prices, i.e. on how much they charge for their flight tickets.
66. The price at which a consumer can buy a plane ticket varies depending on a variety of factors, such as travel date and time, origin and destination, travel class, booking method, number of purchased tickets or loyalty programs.93 These differences are in part related to drivers of costs (e.g. flying farther away is more costly), but they also represent ways to discriminate between customers depending on their ability and willingness to pay.94 The number and level of fares published in airline tariff manuals may therefore vary significantly for a specific flight by a given airline.95
67. In an attempt to lower costs and to attract no-frill customers, LCCs, led by Ryanair, have started introducing complete “à la carte” services by un-bundling services.96 Under this system, a no-frill flight is proposed and priced distinctly (basic fare) from ancillary services (e.g. priority seating or extra luggage), each of which has a separate price tag. This prompted legacy carriers to also un-bundle their offer and depart from the usual “all-in” flight experience. A danger arising from un-bundled offers is that it may to lead to “drip pricing”. Drip pricing is a pricing technique by which firms advertise only part of a product’s price and reveal other charges later, as the customer goes through the buying process. The additional charges can be mandatory charges or optional fees for upgrades and add-ons.
90 See section 3.3.a. for a competition assessment of loyalty scheme under exclusionary conduct claims. 91 Decision V2002-28 of the Norwegian Competition Authority.
92 The ban was renewed by the government in 2007, and discontinued in 2013: the government believed that the ban against abuses of dominant position and the work of the Competition Authority would suffice to ensure that airlines did not use loyalty schemes in an anti-competitive manner.
93 Hanlon (2007), Chapter 6. Pricing power, page 239. 94 Beloba et al. (2009).
95 Hanlon (2007), Chapter 6. Pricing power, page 239.
96 Forsyth et al. (2013), Chapter 10, A la Carte Pricing to Generate Ancillary Revenue: the Case of Ryanair, page 185.
68. Un-bundled offers may bring significant consumer benefits by allowing them to choose from various menu options, and to tailor products or services to their needs. But price partitioning can also cause harm to consumers, by misleading their choice by making prices less transparent and comparisons more complicated. Competition and consumer protection agencies have raised concerns about the use of drip pricing and some of them have taken or prompted action against potentially harmful drip pricing strategies.
Box 3. Drip pricing risks in the airline industry: Regulatory and enforcement actions
EU: The European Parliament and Council have adopted a Regulation on common rules for the operation of air services under which:97
• The final price to be paid shall at all times be indicated and shall include the applicable air fare or air rate as well as all applicable taxes, and charges, surcharges and fees which are unavoidable and foreseeable at the time of publication.
• Optional price supplements shall be communicated in a clear, transparent and unambiguous way at the start of any booking process and their acceptance by the customer shall be on an ‘opt-in’ basis.
UK: In a market study report on price advertising,the OFT (now CMA) indicated that it is less likely to consider enforcement action where a trader has e.g.: 98
• Included all compulsory charges in the upfront price;
• Given information with the headline price about compulsory elements of a product that attracts variable charges (e.g. payment methods).
In September 2011, the OFT opened an investigation into payment surcharges in the airline industry. The 14 airlines under investigation had not complied with the above OFT report on price advertising. The OFT was concerned that airlines' payment surcharges were a 'drip-fee' or 'price partitioning' device, which concealed the true price of their services. The airlines under scrutiny gave formal undertakings to the OFT, whereas others brought voluntary changes to their pricing practices. The OFT concluded that, as a result of this enforcement action, free payment by debit card would become the industry standard for UK passengers.99
69. The disparity in air fares is further reflected in the existence of two parallel “pricing worlds”. On the one hand, there is the world of public transparent prices. Airlines file their prices with companies such as SITA or ATPCO,100 which in turn make fares available to Global Distribution Systems.101 Global Distribution Systems use sophisticated algorithms to display air fares instantaneously in a comparative format based on consumers’ search criteria.102 These are the prices everyone can see by looking for flights and quotes on Expedia or Travelocity for example. Airlines may also make air fares public on their own websites. On the other hand, there is also a whole world of non-public prices resulting from corporate contracts or obtained through frequent flyer programmes. These various pricing worlds may complicate pricing analyses, notably when it comes to assessing the impact of potential anti-competitive conducts on air fares.
97 EU Regulation 1008/2008, article 23.
98 UK OFT, Advertising of Prices, market study (2010). 99 UK OFT decision, Airline Payment Surcharges (2012).
100 Borenstein (2004), page 235: “A central clearinghouse for distribution of fare change information”. 101 Global Distribution Systems (GDSs) are also called Computer Reservation Systems (CRSs). 102 For a description of this distribution system, see Borenstein (2004), pages 235 and 236.
